After a period of unusually happy and smooth equity gains from April to September, the volatility that tattooed February and March of this year is seemingly back. Stock markets suffered their sharpest decline since early February, with as much as a 7% drop in the S&P 500.

This makes sense – volatility should be higher than normal at a late stage in the cycle and with many moving parts such as tightening central banks, a shifting inflation regime and the winds of protectionism.

But why did stocks drop so suddenly and so abruptly?

There are many interwoven theories as to why the stock market fell; and probably the best guess is that interest rates had risen abruptly in the weeks beforehand. Another solid hypothesis is that the IMF had recently downgraded its growth outlook, signaling less macro enthusiasm on the horizon.

Elsewhere, we could speculate that it was due to US-China trade tensions intensifying – a serious macro risk; a surprisingly powerful hurricane in the US might have spooked markets; or else, maybe simply that the month of October is notorious for its sharp stock market swings.

On the latter, there is a tentative pattern of equities being soft in the lead-up to the US mid-term elections, followed by strength thereafter. However, on this last subject, it is less clear why markets would celebrate the likely ascension of Democrats to the House of Representatives after Republicans blessed risk assets with tax cuts in the present Congressional term.

What is important to recognise here is the folly of trying to precisely map macro onto markets.

For all of this analysis, let us recognise that hindsight cannot truly claim to be 20-20 when financial markets are involved. While all of the aforementioned reasons are perfectly reasonable guesses for why the stock market suddenly turned sour, we cannot simply pull out a calculator and tally up the precise effect of each one.

Moreover, many of these developments had been apparent for weeks or longer before the stock market got a hold of them. Thus, there is still an element of mystery as to why the stock market picked one particular weak to recoil so powerfully.

The reality is that financial markets occasionally stumble into virtuous or vicious circles, rising or falling beyond reasonable expectation as changes in sentiment build upon themselves.

Illustrating the folly of trying to identify the precise rationale for market turns, one could imagine that instead stocks had continued to rise happily over the past week. How might pundits justify that?

Probably via the observations that the US economy is red hot, the global economy is solid and the successful USMCA trade deal is still casting a warm glow. The reality is that there are always a mix of good and bad things happening in the global economy at any time, and rarely does one side obviously overwhelm the other.

While one can never speak with absolute confidence about the market outlook, this stock market slide probably isn’t the beginning of the end, for several reasons.

First, US growth remains stellar, and this feeds into earnings. Global growth is also decent, and furthermore stock valuations were not unreasonable given the broader context. Crucially, however, credit markets are holding together fairly well, and they are often a bellwether for other asset classes. We continue to believe the developed world is at a fairly late stage of the cycle, but not yet at the outright end of the cycle.

Episodes of stock market distress are never pleasant, but panic is rarely appropriate. Drawdowns such as this one are usually short lived, whereas investing is ideally a long-term pursuit. Rarely does a company’s future stream of earnings genuinely shrink by 5% or 7% in a handful of days.

It is perhaps a more complicated matter to determine whether expectations were too optimistic beforehand or too pessimistic afterward, but the future likely hasn’t been altered that drastically so quickly.

With admitted exceptions, it rarely pays to sell after a sharp decline. While the right asset mix depends on the point in the cycle, rarely is a large hunk of cash a good investment bet.

To that end, we recently reduced our already slim cash holdings further by deploying them into the bond market now that yields are more attractive, and we remain modestly overweight equities.

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